HatchConf Business Value and M&A Process

MERGERS & ACQUISITIONSCORPORATE FINANCE

MARKET INTELLIGENCEBUSINESS VALUATION

EXIT PLANNING

Investment Bankers To The Middle Market

What’s your Business Worth?

MERGERS AND ACQUISITIONSCORPORATE FINANCE

MARKET INTELLIGENCEBUSINESS VALUATION

EXIT PLANNING

Investment Bankers to the Middle Market

HARRY WARDHAMPTON ROADS [email protected]

Confidential and Proprietary 2

Introduction to The McLean Group

Middle-market investment bank with extensive reach and experience. Private Company M&A, Capital Formation Business Valuation Market Intelligence Exit Planning

Broker/dealer serving the middle-market ($5M to $500M in revenue) McLean Securities, a wholly-owned affiliate, is a registered broker/dealer with

FINRA; Member, Securities Investor Protection Corporation (SIPC)1

Headquartered in the Northern Virginia technology corridor near Washington, D.C. with 30 North American offices.

International desk with network of 200 close affiliates in 35 countries.

1. All advisors are fully-licensed to facilitate securities transactions as mandated and actively enforced by government regulatory bodies with unique technical depth – CPAs, CFAs, MBAs, certified negotiators, M&A and valuation experts.

Confidential and Proprietary

Objectives:

• Define the Middle Market• Discuss Types of Buyers• Show How Buyers Value a Company• Contrast Seller’s Approach to Value• Discuss the M&A Process


Defining Our Middle Market:

Revenues from $5 million to $500 million

Less than $5 million: “Mom and Pop” - best served by business brokers;Greater than $500 million: best served by Wall Street and some regional I-banks.


Buyer Types Help Drive Business Value:

Strategic – Industry Consolidators Operational means: economies of scale, new markets, market share, “synergies”

Financial – Private Equity Financial engineering and operational efficiencies

Roll-up groups Financial engineering

Industry (non-strategic) Bottom-fishers (opportunistic)

Individual Buyers Last ditch effort, very rare in MM

Buyer Type Generates value through…


Another View of the Buyers

Source: Mergerstat Review


Business Valuation Basics

7


Formal vs. “Street” Valuations

• Formal (Report)

Appraisals of Equity for legal purposes

Several Measures: FMV, Investor Value, Fair Value

Assumes Symmetric knowledge

Cash/Non-contingent Consideration

• M&A (The street) Always Investment Value

of whole enterprise Real-world transaction

comparables Asymmetric Knowledge is

reality Mixed Consideration,

often Contingent

** Appraisals are of little value to a seller: each buyer drives a different value **


M&A Valuation Dynamics:

BuyersDetalied Calculations

1.DCF / Capitalized Cash Flows

2.Comparable Transactions• Unavoidable!

SellersPreliminary Calculations

1.Comparable Transactions

2.DCF / Capitalized Cash Flows• Understand Buyer’s view

Negotiated Agreement

Buyer’s investment value and synergies balanced with market influences in auction

Key Issue: Who gets the value of buyer’s synergies?


Buy Side: Discounted Cash Flows (DCF)

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• What? Earnings before interest, taxes, depreciation and amortization (EBITDA);

• Why? EBITDA is a close approximation to cash flow; removes the effects of financing and cap investment decisions

• Who cares? Buyers care because cash-flow comparisons allow them to evaluate alternative investment vehicles that provide cash flows – Bonds 5% (20 times multiple)– Real Estate (commercial) 9% to 11% (11 to 9 times multiple)– Large cap stocks 12% (8 times multiple)– Small cap stocks 21% (4.8 times multiple)

EBITDA: Pre-Tax Cash Flow


Normalize for “Real” EBITDA

Reported net taxable incomeAdjustments:Add back owner salary > $200K Add back interest long term debt Add non-recurring expenses Add back depreciation Normalized net (EBITDA)

500,000

400,000

50,000 250,000

. 50,000

1,450,00

$

$$$

Or Pre-tax Cash Flow


• EBIT = Earnings before Interest and Taxes• EBITDA = add depreciation and amortization

(and normalize)

• EBITDA minus Capital Expenditures – Buyer estimates CAPEX to sustain operations

• EBITDA minus CAPEX & Changes in Working Capital (aka Cash Flow to the Firm)

– Need more WC to execute plans? Must reduce cash flow as a buyer

13

Cash Flow to the Firm

Standard for seller market multiples >

Standard used by most buyers for

DCF >


Basic DCF

1. Buyer calculates Cost of Capital *2. Forecast 3 – 5 years cash flows and terminal value3. Discount each year and terminal value by cost of capital

EXAMPLE

Year 1 Year 2 Year 3 Terminal

Forecast cash flow 2,200 2,500 2,900 30,000Present value at 12% 1,964 1,993 2,064 21,353

Sum all DCF’s for Total Enterprise Value: $27,374

* Various Flavors: WACC, Discount Rate, Cap Rate, IRR


Sell Side: EBITDA Multiples

15


Multiple Realities in the Middle Market:

• Usual range 4.5x – 5.5x EBITDA• Possible range 1x - 12x • Higher ranges may be justifiable in hot industries

with high growth rates, and• Lower ranges are more likely in professional services,

resellers, commodity and “buggy whip” businesses).


Value Driver Considerations

Growth

Size

Proprietary Assets/Differentiation

Customer/Supplier concentration

Ratio Comparisons

Cyclicality (e.g. construction)

Professional goodwill/key management

dependence

In gov’t contracting: transferability of contracts


(in the Marketplace)

Normalized net income (EBITDA) $ 6,000,000

Preliminary multiple 6 X

Value of earnings $36,000,000

Excess balance sheet value $ 2,000,000

Value of enterprise$38,000,000Minus Liabilities assumed by buyer, e.g. $ 8,000,000

Value of Equity $30,000,000

In the auction – who knows?

Summing Up: Calculating Preliminary Value


Owners – Keep an Eye on Your Exit

Always pursue growth (top and bottom line)

Hire, train, incentivize solid people

Keep balance sheet and business entities clean

(consider housing non-core assets in separate entities)

Diversify customer and supplier bases

Shift from tax optimization to value

optimization

View your company through eyes of potential

suitors (e.g. build a complementary niche market)


Middle Market M&A Process


The M&A Process, Step by Step:

1. Identify and locate prospective buyers;2. Prepare confidential information memorandum and acquisition profile;3. Distribute acquisition profiles to prospective buyers;4. Secure non-disclosure agreements from interested prospects;5. Distribute the confidential information memorandum;6. Negotiate Indications of Interest (IOIs), hold meetings7. Secure letters of intent;8. Conduct due diligence (by buyer);9. Negotiate and prepare the definitive agreement;10. Closing (sounds easy, but “every deal dies a thousand deaths!”)


Timing the Sale: A Big Mistake!

$ Sales

Time

Maximum Value


Beware the Single Offer!

A typical single offeror:A typical single offeror:


Letters of Intent Are Not Invitations to Further Negotiation

Buyer

Seller

ManagementPresentation

Multiple Offers

LOI NegotiationsExclusivity to Buyer Closing

The Seller’s Advantage Curve

Don’t Hide Problems/Issues:


Don’t Assume The “Likely” Identity of the Buyer

30 Transactions: were “Most Likely” Buyers the final acquirer?

Source: Goldsmith Agio Helms

Buyer research & effective Auctions:


Types and Ranges

• Principal elements:– Cash (usually 40% to 80%);– Seller take-back notes (20% to 40%);– Stock (if any, then 20% to 80%), and– Contingent vs. non-contingent consideration

• If any, then 20% to 25% contingent, and• Comfort vs. incentive earn-outs.

M&A Consideration:


The Top 14 Seller Mistakes:

8. Being represented by an unlicensed broker

9. Communicating your asking price inappropriately

10. Eliminating offshore buyers11. Assuming the type of buyer12. Waiting until management

is ready to retire13. Waiting for next year’s

growth14. Ignoring or over-

emphasizing timing

1. Selling it without representation

2. Selling to a single offeror

3. The poorly constructed earn-out

4. Disclosing an insufficient amount of information in Offering Memo

5. LOI not thorough6. Focusing on history and

numbers instead of future opportunity

7. Mismanaging team, end runs


National Office Locations

McLean, VA – Headquarters

Anchorage, AK

Asheville, NC

Atlanta, GA

Austin, TX

Baltimore, MD

Boston, MA

Bozeman, MT

Buffalo, NY

Chicago, IL

Cleveland, OH

Columbus, OH

Erie, PA

Green Bay, WI

Hartford, CT

Headquartered in McLean, VA, The McLean Group has built a national presence in middle market investment banking with offices in 30 cities nationwide. Each of The McLean Group’s investment bankers brings a unique breadth of experience and expertise to the firm.

Halifax, Nova Scotia

Lafayette, LA

Miami, FL

Milwaukee, WI

Norfolk, VA

Phoenix, AZ

Reno, NV

Sacramento, CA

San Diego, CA

San Francisco, CA

Silicon Valley, CA

St. Louis, MO

Tallahassee, FL

Tampa, FL

Tulsa, OK

National Offices


The McLean Group, LLC

7900 Westpark Drive, Suite A320

McLean, VA 22102

703.827.0200

The McLean Group Hampton Roads, VAHarry Ward, Director

3181 Shore Drive

Virginia Beach, VA 23451

757.613.0476

Economy & Finance

HatchConf Business Value and M&A Process